AURORA: What prompted Habib Bank Limited (HBL) to launch their Islamic Banking operations, when full-fledged Islamic banks are already present in the market?
ZAHID PAREKH: HBL is the largest bank in Pakistan and has a nationwide presence of over 1,700 branches. As soon as Islamic banks began to establish a foothold in Pakistan, the majority of our 10 million plus customers expressed an interest. In light of this, the management decided to add Islamic banking products to our portfolio to keep our customers satisfied and grow our share of the pie. There was a lot of encouragement from the State Bank of Pakistan (SBP) because they wanted HBL, a major player in the banking sector, to start their own Islamic banking window operations.

A: What has contributed to the incremental growth of Islamic banking in Pakistan?
ZP: Islamic banking has evolved as a natural phenomenon. In a country where the majority of the population is Muslim and therefore has a preference for Islamic banking, the sector’s growth was expected. The government and SBP have played an instrumental role in developing and promoting this sector. Although the government has maintained a keen interest in Islamic banking, the scope of products available was largely limited to PLS accounts, and these were not strictly Islamic. Over the years, a mandate was given to the SBP to initiate industry wide Islamic banking practices and subsequently, banks began introducing Islamic finance and banking products, but on a limited scale. The market response was promising, and Islamic banking took off almost immediately simply because of the tremendous demand.

A: SBP bulletins indicate that the growth of Islamic banks has outpaced that of conventional banks. Despite this, why is it that the sector has consistently failed to meet the targets set by SBP?
ZP: The targets set by the SBP are always very optimistic. For instance, achieving a 20% share by 2020 is the new objective. It is achievable, but there are factors that pose obstacles. A major issue is that under the HBL balance sheet, we are required by SBP’s Shariah board to have a separate balance sheet for our Islamic banking operations that is separate from the parent company. This implies that we have our own assets and have to manage our liquidity separately. The question for the sector is, how do they place their excess liquidity in the market, given that the options to do so are limited? The most commonly used are Sukuks (Shariah-compliant bonds), but the problem here is that both the issue date and the frequency of issue is very uncertain. So, once Sukuks are bought, Islamic banks are unwilling to sell them, and here we face the problem that there is no secondary market for Sukuks. For the sector to grow and meet the targets set, banks need the facility to come in and go out of Sukuks when needed. Not investing liquid cash means that banks keep them at a zero percent rate of return and that is not an intelligent strategy.

A: Who is responsible for creating and developing this secondary market?
ZP: The market does exist but is it limited in terms of scope and volume. The problem is that government priorities on Sukuks also change. These days, the government is focused on issuing external Sukuks and unfortunately, we cannot invest in those for the simple reason that almost all of our deposits are in local currency and if we invest local currency into foreign currency Sukuks, we face the risk of exposure; no financial institution wants to be in a position whereby their investments can be diluted due to fluctuating currency exchange rates.

Pakistan is at the forefront of spearheading innovation and developing the Islamic banking sector globally. In terms of volume and numbers alone, countries such as Malaysia and the UAE may be further ahead, but as far as the breadth and depth of the product portfolio and institutional capabilities are concerned, Pakistan is not lacking in any area.

A: A frequent criticism is that Islamic banking is ‘Islamic’ in name only, and that the products are the same as those offered by conventional banks. How challenging has it been to counter this perception?
ZP: Initially, this posed a significant challenge. Before convincing people, we had to train our staff and explain what makes Islamic banking fundamentally different. The market had to be made aware of the fact that with Islamic banking, all products are backed by assets, which is not the case in conventional banking. The population can be segmented into three different groups. The first comprises people who understand the principles of Islamic banking and want to use our products and services. These are the faith-based customers. The second segment comprises the sceptics who are doubtful of the authenticity of the claims of Islamic banks. However, they can be convinced if we are able to answer their questions and provide clarity. The third group are people who believe that Islamic banking is a gimmick and are unwilling to listen to reason. Our initial focus was to bring in the faith-based segment and we are now targeting the sceptics through personalised, awareness campaigns. We have organised road-shows, conferences and seminars where our Shariah board members interact with people, offer clarity, answer questions and explain the differences between conventional and Islamic banking. These initiatives have made a difference in changing mindsets and expanding our customer base.

A: Is customer demand concentrated in the metropolitan cities only or does it extent to second-tier cities and the rural areas?
ZP: Demand exists throughout Pakistan, across all the provinces, in small towns and large cities. In the rural areas, if people are given a choice between conventional and Islamic banking, they opt for the latter. However, to some extent, demand is affected by pricing considerations. For instance, rentals in an Ijarah contract may be higher than the amount charged by a conventional bank for an auto loan. People need to understand that the higher rental payment is due to the fact that the Islamic bank is assuming a higher degree of risk because if the asset is stolen, the Islamic bank cannot charge any rental on it from that point on, whereas with a conventional auto loan, the customer must continue making payments, regardless of the state of the asset. These are the kinds of differences that people are unaware of and it is up to the banks to disseminate this information.

A: How diverse is HBL’s Islamic banking portfolio?
ZP: It is very broad in scope and there are solutions for all kinds of customer segments ranging from Murabaha, Istisna, Salam, Ijarah, running Musharaka and diminishing Musharaka, to name a few. Each one is tailored to suit the financial requirements of different segments. For instance, Murabaha is the preferred choice of the SME sector and it is essentially cost plus financing. If a start-up is interested in importing an asset, they will approach the bank and provide details of the required financing arrangement. The principles of a Murabaha contract are that the bank will purchase the required asset on behalf of the customer. Once we have the asset in our possession, the cost of purchase incurred by the bank and the percentage of profit that will be charged from the customer are disclosed in the contract. The SME repays the amount at a later date, which means that Murabaha is based on a system of deferred payments. On the other hand, large scale corporate entities prefer Musharaka, whereby the bank provides financing through which they can manage their working capital requirements. A product we are looking to introduce in the forthcoming months is a Shariah-compliant mortgage solution because there is considerable demand for this in the market.

A: Which products have proved to be the most popular with corporate and retail customers?
ZP: Murabaha, running Musharaka and Ijarah. A significant change in the market has been the shift from Ijarah to diminishing Musharaka, in which an asset is jointly owned by the bank and the customer. The mode of transaction is such that customers make periodical payments through which they buy out the bank’s partial ownership of the asset, so that by the time the diminishing Musharaka contract matures, customers are the sole owners of the asset. The main reason why this shift is taking place is because there are tax and accounting issues with Ijarah that need to be resolved.

HBL has been a frontrunner in FinTech. We established our Innovation and Financial Inclusion Department almost two years ago, with the sole purpose of digitising our processes and services and make it convenient for customers to bank with us. Our Islamic banking division has started working with this department on a few projects and through this collaboration, we will be able to improve customer service and efficiency while making Islamic banking products more easily available to our customers, even in remote areas.

A: What has been the differentiating factor for HBL’s Islamic banking division, given that almost every bank has Islamic banking operations?
ZP: Our credibility and our extensive branch network are our strong points. Also, the skill-set and knowledge of our employees is unmatched. We have trained over 4,000 employees in Islamic banking principles, products and solutions and this has been a key factor. It is important to remember that until 2002, Islamic banking did not exist as a separate category. As the sector began growing, the workforce joining Islamic banks comprised people who had started their careers at conventional banks. That meant that every new hire had to be educated about the differences between conventional and Islamic banking. The situation has improved considerably and several higher education institutions have added Islamic banking degrees to their curriculum. As the sector has grown, several independent institutions have started offering specialised certifications; there is also the option of pursuing online courses in this discipline. With the continued expansion of the sector, banks have established in-house learning and development departments responsible for providing ongoing education so that employees stay abreast of the latest developments in Islamic banking globally. The role of Shariah scholars in sharing their expertise and collaborating with Islamic institutions to set benchmarks must also be commended.

A: In the last two to three years, FinTech has emerged as a buzzword in the banking industry as a way to increase financial inclusion. What initiatives have HBL taken with regards to using FinTech in their Islamic banking operations?
ZP: HBL has been a frontrunner in this area. We established our Innovation and Financial Inclusion Department almost two years ago, with the sole purpose of digitising our processes and services and make it convenient for customers to bank with us. Our Islamic banking division has started working with this department on a few projects and through this collaboration, we will be able to improve customer service and efficiency while making Islamic banking products more easily available to our customers, even in remote areas. However, there are certain challenges that need to be addressed when it comes to enabling Islamic banking through FinTech. It is important to understand that an Islamic bank essentially operates as a trader of goods and services and that complying with Shariah guidelines requires extensive documentation. For instance, if we buy an asset with the intention of selling it to a customer, before the transaction can be completed, the asset must be inspected by an expert and witnesses are needed to sign off that the transaction is legitimate and Shariah compliant. Digitising this process is extremely complex because of the amount of documentation every Islamic finance transaction requires. The concept of FinTech is still new in Pakistan, although I believe it can prove to be a game-changer not only for the Islamic banking sector, but for the overall banking sector as well. Another obstacle is obtaining approvals from our Shariah board before digitisation can take place. HBL’s Shariah board have, in principle, given us approval to proceed with FinTech solutions and that is a positive development.

A: Compared to the rest of the world, where does Pakistan’s Islamic banking sector stand?
ZP: Pakistan is at the forefront of spearheading innovation and developing the Islamic banking sector globally. In terms of volume and numbers alone, countries such as Malaysia and the UAE may be further ahead, but as far as the breadth and depth of the product portfolio and institutional capabilities are concerned, Pakistan is not lacking in any area. Going forward, the potential of Islamic banking is undeniable, although how it fares will depend on several factors. The first is the overall profitability of the banking industry. If the industry continues to post steady numbers, this will encourage more banks to launch Islamic banking divisions, diversify their products and find better ways of managing their risks and exposure. If the issue of liquidity placement can be resolved, this will surely propel the sector to new heights. The SBP and the government are very supportive and perhaps the only improvement we can ask for is in terms of regulating the frequency with which Sukuks are issued by the government as this has a direct impact on the ability of Islamic banking institutions to maintain their profitability.

Zahid Parekh was in conversation with Ayesha Shaikh. For feedback, email aurora@dawn.com